Mortgage Refinancing Guide

What is Refinancing?

Refinancing is the process of replacing an existing mortgage with a new one, typically to take advantage of better terms or lower interest rates. When you refinance, your new mortgage pays off the old one, and you begin making payments on the new loan.

Understanding the Two Types of Savings

Monthly Payment Savings

This is the reduction in your monthly mortgage payment. While lower monthly payments provide immediate cash flow benefits, they don't always translate to long-term savings, especially if you extend your loan term.

Total Interest Savings

This represents the difference in the total amount you'll pay over the entire life of the loan. Sometimes, refinancing may increase your monthly payment (by shortening the term) but save you significantly on total interest.

Common Refinancing Scenarios

Lower Rate, Same Term

The ideal scenario: lower monthly payments and lower total interest. This is typically achieved when you refinance to a lower interest rate while keeping the same loan term.

Lower Rate, Longer Term

You'll get much lower monthly payments, but you might end up paying more in total interest over the extended period. This approach prioritizes immediate cash flow over long-term savings.

Lower Rate, Shorter Term

Your monthly payments might increase or stay similar, but you'll pay off the loan faster and save significantly on total interest. This approach prioritizes long-term savings over monthly cash flow.

When to Consider Refinancing?

1. Interest Rates Have Dropped: A common reason to refinance is when market interest rates fall below your current mortgage rate.

2. Improved Credit Score: If your credit has improved significantly since getting your original mortgage, you might qualify for better rates.

3. Changing Loan Terms: You might want to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage or change your loan term.

4. Need for Cash: A cash-out refinance allows you to borrow against your home's equity.

Key Refinancing Factors to Consider

Break-Even Point

The break-even point is when the savings from refinancing exceed the costs. To calculate:

• Divide the total closing costs by your monthly savings
• The result is the number of months needed to break even

For example, if closing costs are $4,000 and you save $200 monthly, your break-even point is 20 months.

Closing Costs

Refinancing isn't free. Typical costs include:

• Application and origination fees
• Appraisal fees
• Title search and insurance
• Attorney fees
• Prepayment penalties (on your old mortgage)

These costs typically range from 2-5% of the loan amount.

Interest Rate vs. APR

• Interest Rate: The basic rate charged on the loan amount
• APR (Annual Percentage Rate): Includes the interest rate plus other costs like mortgage insurance and closing costs

Always compare APRs when shopping for a refinance.

Loan Term Considerations

• Shorter Term: Higher monthly payments but less interest paid over the life of the loan
• Longer Term: Lower monthly payments but more interest paid over time

Potential Pitfalls

• Extending the Loan: If you've paid 10 years on a 30-year mortgage and refinance to a new 30-year loan, you'll be paying for 40 years total. Your monthly payments might decrease, but your total interest paid will likely increase.

• Moving Soon: If you plan to move in a few years, you may not reach the break-even point and refinancing could cost you money.

• Focus on Monthly Payments Only: Don't be tempted by lower monthly payments without considering the total cost of the loan over its lifetime.

Final Tips

• Always compare both monthly payment changes AND lifetime interest changes
• Consider your financial priorities: cash flow now vs. total savings later
• Calculate your break-even point before deciding
• Think about how long you plan to stay in your home
• Shop around and get quotes from multiple lenders